ASC 740 – Income Tax Provision Challenges 2014

© 2014 Hein & Associates LLP. All rights reserved.

ASC 740 – Tax Provision ChallengesPatrick Hanley, Tax Partner

Brian Parmelee, Director, Tax Provision Services

December 3, 2014


Notice

This document contains general information, may be based on

authorities that are subject to change, and is not a substitute for

professional advice or services. This document does not

constitute assurance, tax, consulting, business, financial,

investment, legal or other professional advice, and you should

consult a qualified professional advisor before taking any action

based on the information herein. Hein & Associates LLP is not

responsible for any loss resulting from or relating to reliance on

this document by any person.


Agenda

• Regulatory Areas of Focus

• Areas with Computation/Reporting Challenges:

– Valuation Allowances

– Deferred Taxes

– Stock Compensation

– Interim Tax Rate

– Intraperiod Tax Allocation

– Uncertain Tax Positions

• New GAAP Guidance

• Q&A


Regulatory Areas of Focus

• PCAOB

– Audit evidence associated with management

estimates

• Valuation allowance assertion

• Uncertain tax positions

• Indefinite reversal criteria (APB 23)

– Internal controls

• Management review of controls

• Completeness and accuracy of data

• Valuation allowance support and documentation


Regulatory Areas of Focus, cont’d

• SEC

– Valuation Allowances

• Recognition

• Reversal

• Financial Statement Disclosures

– Uncertain Tax Position Items

• ASC 740-10-50-15 disclosures

• Interest and penalty presentation policy disclosures

• Basis for recording changes

– IRS Examinations

– Interim Items


Regulatory Areas of Focus, cont’d

• SEC

– Other

• Rate reconciliation items

• Deferred tax assets and liabilities

• Timing of reversals

• Expiration of NOLs in various jurisdictions

• Critical accounting policies and material assumptions

• Consistency of APB 23 assertion (undistributed earnings of

foreign subsidiaries)


Valuation Allowance Considerations

• All available evidence, positive and negative, must be

considered

• Weight items based on extent to which they may be objectively

verified

• Determined separately for each jurisdiction


Valuation Allowance Considerations,

cont’d

• Examples of Negative Evidence

– Cumulative losses in recent years• Significant negative evidence difficult to overcome

• “Losses” = pretax book losses

• “Recent years” = current year and prior two years

– Expected future losses

– Brief carryback/carryforward periods

– Special character of income (i.e. capital) required to realize tax benefits

– History of carryforwards expiring unutilized

– Management historically unable to accurately forecast future earnings

– Unfavorable trends, developments or contingencies

– Going concern issues



cont’d

• Examples of Positive Evidence

– Strong earnings history

– Appreciated net asset values

– Taxes paid in potential carryback years

– Availability of tax planning strategies

– Favorable recent developments

– Sales backlog



cont’d

SEC Comment Letter regarding basis for not having a VA

“In light of the negative trends in your results of operations in

2008 and 2009, in future filings please expand the discussion of

your rationale regarding the recoverability of net deferred tax

assets to provide a balanced discussion of all of the significant

positive and negative factors management considered in

concluding that net deferred tax assets are more likely than not

recoverable. Also, clarify how you weighted and evaluated the

factors you cite. To the extent realization of net deferred tax

assets is dependent on tax planning strategies or non-routine

transactions, please disclose and describe.”



cont’d

SEC Comment Letter regarding VA consistency with otherinformation

“We note that your valuation allowance is less than 1% of your deferred taxassets. In addition:

– You state on page 35 that you expect lower future revenue,

– Your independent auditors issued a going concern opinion,

– Your credit ratings have been downgraded,

– You expect future non-compliance with debt covenants,

– You impaired all of your goodwill as well as other assets, etc.

As such, tell us and disclose in detail why you believe it is more likely than notthat most of your deferred tax assets will be realized. Disclose if there areindications that the valuation allowance will change in the near term due to oneor more future events and the nature of the uncertainty and a range of possibleoutcomes. In addition, please describe how you will realize your deferred taxassets. Describe the business development risks, specific tax planningstrategies and other factors that lead to your conclusion.”


Allocation of Valuation Allowance

• ASC 740-10-45-5 provides that the valuation allowance

for a particular tax jurisdiction shall be allocated between

current and noncurrent DTAs for that tax jurisdiction on a

pro rata basis

• Classification of DTA/DTL on the balance sheet generally

based on underlying balance sheet item.

– DTAs/DTLs related to items classified as current in the

financial statements are recorded as Current DTAs/DTLs

• Derivatives

• ARO

• Allowance for Doubtful Accounts


Allocation of Valuation Allowance,

cont’d

• DTAs/DTLs related to items classified as noncurrent in

the financial statements are recorded as Noncurrent

DTAs/DTLs

– Property

– Intangibles

• Deferred tax items that do not relate to an identifiable

asset or liability in the financial statements are classified

according to expected reversal date

– NOLs

– Credit carryforwards


Allocation of Valuation Allowance,

cont’d


Deferred Taxes

• Tax basis balance sheet

– Deferred taxes should be tax effect of difference between book

basis and tax basis at the balance sheet date

• Not rollforward of cumulative book/tax differences.

• May result in same answer but balance sheet comparison is the appropriate

method.

– True tax basis balance sheet approach involves a balance sheet

prepared from double-entry accounting system maintained on a

tax basis.

• At a minimum, maintain cumulative M-3 schedule and property/ intangible

rollforwards on a tax basis.

• Acquisition accounting may create additional differences outside of

Cumulative M-3.

• Have clients/3rd party provision preparers prove deferreds via this method

once per year – we generally require 3Q after the returns have been filed.


Deferred Taxes, cont’d

Deferred Rollforward Balance Sheet Comparison


Deferred Taxes, cont’d

• True ups can create issues with:

– Timing of recognition

– Impact on internal controls

– Error versus change in estimate

• Continues to be an area with challenges and

contributes to deficiencies related to accounting for

income taxes


Naked Credits

• Indefinite-lived intangibles

– Taxable temporary differences not predicted to reverse

– Cannot consider reversals that only occur with impairment

or sale


Naked Credits – Identification

Example


Naked Credits – Identification

Example, cont’d


Stock Compensation

• Guidance

– When the settlement of an award creates or increases an

NOL, the excess tax benefit (tax compensation in excess

of GAAP compensation) and the credit to APIC should not

be recorded until the entity realizes the tax benefit – i.e.

the deduction reduces taxes payable.

• Result

– The DTA for NOLs will differ from the actual NOLs per the

entity’s tax return.

– Track equity NOLs separately.


Stock Compensation, cont’d



• Accounting Policy for Realization

– Generally, two approaches allowed:

• With and without – results in excess tax benefits realized last

• Tax law ordering – results in excess tax benefits realized first

– Election and method is an accounting policy that must be

applied consistently.



• Example – Facts:

– NOL Carryforward from Prior Years – Actual Per Tax

Return $500,000

– Current Year Taxable Income (Before Stock Comp

Deduction $600,000

– Current Year Excess Tax Benefit Deduction for Stock

Based Comp $250,000

– Tax Rate of 40%


Interim

• Each interim period treated as a separate accounting period

• At the end of each interim period, the Company:

– Estimates the Annual Effective Tax Rate (“AETR”) it expects for theyear using the most current information at the time

– Determines which items impacting the rate should be treated asdiscrete

– Applies the AETR to YTD ordinary income or loss

• Discrete items

– Discrete items are those items that are not part of the AETRcalculation, often relating to changes to items recorded in a priorperiod

– Full impact recorded in the interim period identified/enacted/changein judgment, etc.


Interim, cont’d

• AETR Items, including not limited to:– Expected permanent items

– Tax credits

– Foreign tax rates

– Valuation allowance for DTAs arising in current year

– Accrual of UTBs related to current year items

– Change in intention for undistributed earnings of the current year

• Discrete Items, including not limited to:– Valuation allowance for DTAs existing at beginning of year

– Valuation allowance release related to expected use ofpreviously valued attributes in future annual periods


Interim, cont’d

• Discrete Items:

– Changes in tax laws or rates recognized in interim period that

includes enactment date

– Return to provision adjustments in interim period return filed

– Adjustment to UTB specific to prior years

– Accrual of interest (if classified as a component of tax expense)

and penalties for prior year uncertain tax positions

– Change in judgment for establishment/reversal of the DTL

related to outside basis difference that had accumulated as of

the end of the prior year


Interim, cont’d

• Exceptions to AETR:

– Ordinary income or loss in total cannot be reliablyestimated

• e.g. if an enterprise expects near break-even operations suchthat small changes in estimated ordinary income/loss results inlarge changes in the estimated AETR

– Individual items of ordinary income or loss cannot bereliably estimated

• e.g. receipt of tax exempt interest income or foreign exchangegains or losses

– Must ensure you give consideration of this assertion to allaspects of the interim period

• e.g. impairments if argument that book income cannot be reliablyestimated due to volatility of oil prices


Interim, cont’d

• Balance Sheet Considerations

– Calculation of interim period should be consistent with

balance sheet approach of annual provision.

– Does this require a full provision?

– How do you reconcile change in DTAs/DTLs when

short-cut method applied – AETR applied to book

income/loss for the Q?

• Current versus noncurrent deferreds


Interim, cont’d

SEC Comment Letter regarding use of discrete rate:

“It appears from the disclosures on page 8 that the company has had a

change of method in computing income taxes from the annual effective

rate method to the discrete effective rate method. However, as ASC

740-270-25-2 requires that an annual effective tax rate be determined

and such annual effective rate applied to year to date income in interim

periods under ASC 740-270-30-5, we are unclear as to the method the

company is using. Your disclosure indicates that you calculate income

taxes in interim periods using the discrete effective tax rate applied to

year to date income. Please tell us how your calculation of interim taxes

complies with ASC 740-270-25-2 and ASC 740-270-30-5. We may

have further comment upon receipt of your response.”


Interim, cont’d

Sample footnote when discrete method versus annual

effective tax rate method is utilized:


Interim, cont’d

SEC Comment Letter regarding change in balance sheet at

interim period:

“We note that the balance of the current and non-current portion of

deferred income tax assets remained unchanged from year-end April

30, 2009 to quarter-end October 31, 2009. Tell whether you perform an

analysis of your current and long-term deferred income tax assets

during the interim periods and specifically address how you considered

the guidance in ASC 740-270 in accounting for your interim period

taxes.”


Intraperiod Tax Allocation

• Discontinued Operations

– With and without

– Presentation of balance sheet

– Rate reconciliation (not disclosed)


Intraperiod Tax Allocation, cont’d

• The Basic Model

– Step 1: Compute the total tax expense or benefit (bothcurrent & deferred) for the period.

– Step 2: Compute the tax effect of pretax income or lossfrom continuing operations, without consideration of thecurrent-year pretax income from other financial statementcomponents.

– Step 3: Allocate among the other financial statementcomponents, in accordance with the guidance in ASC 740-20-45-12 through 45-14 the portion of total tax thatremains after allocation of the tax to continuing operations(Step 1 less Step 2).



• Example 1

– Facts• In 20X6, an enterprise has $1,000 of income form continuing

operations and $1,000 loss from discontinued operations

• Beginning of year, enterprise has a $2,000 net operating losscarryforward for which the deferred tax asset, net of itsvaluation allowance, is zero, & the enterprise did not reducethe valuation allowance during the year

• Applicable tax rate is 40%

– Question• How should the tax provision for 20X6 be allocated between

continuing operations & discontinued operations?



• Example 1

– Solution

Step 1: 20X6 Tax Provision / (Benefit) with all Financial Statement Components

20X6 Pretax income/(loss) – continuing operations 1,000

20X6 Pretax income/(loss) – discontinued operations (1,000)

Pretax income / (loss) -

Tax rate 40%

Expected tax provision / (benefit) before valuation allowance -

Change in valuation allowance -

20X6 Total tax provision / (benefit) -

Step 1: 20X6 Tax provision / (benefit) with all financial statement components -



• Example 1Step 2 : 20X6 Tax Provision / (Benefit) Attributable to Continuing Operations


Tax rate 40%

Expected tax provision / (benefit) before valuation allowance 400

Change in valuation allowance (400)

20X6 Total tax provision / (benefit) attributable to continuing operations -

Step 3 : 20X6 Tax to be Allocated to Discontinued Operations

Total tax provision / (benefit) (Step 1) -

Total tax provision / (benefit) related to continuing operations (Step 2) -

Tax provision / (benefit) allocated to discontinued operations -



• Example 2

– Facts• In 20X6, an enterprise has $1,000 of income form continuing

operations and $1,000 loss from discontinued operations

• Enterprise has no NOL carryforward .

• Applicable tax rate is 40%

– Question• How should the tax provision for 20X6 be allocated between

continuing operations & discontinued operations?



• Example 2

– Solution

Step 1: 20X6 Tax Provision / (Benefit) with all Financial Statement Components


20X6 Pretax income/(loss) – discontinued operations (1,000)

Pretax income / (loss) -

Tax rate 40%

Expected tax provision / (benefit) before valuation allowance -


20X6 Total tax provision / (benefit) -

Step 1: 20X6 Tax provision / (benefit) with all financial statement components -



• Example 2Step 2 : 20X6 Tax Provision / (Benefit) Attributable to Continuing Operations

20X6 Pretax income/(loss) – continued operations 1,000

Tax rate 40%

Expected tax provision / (benefit) before valuation allowance 400


20X6 Total tax provision / (benefit) attributable to continuing operations 400

Step 3 : 20X6 Tax to be Allocated to Discontinued Operations

Total tax provision / (benefit) (Step 1) -

Tax provision / (benefit) related to continuing operations (Step 2) 400

Tax Provision / (benefit) allocated to discontinued operations (400)


Uncertain Tax Positions

• Presentation of UTB when an NOL, a similar tax

loss, or tax credit carryforward exists

– ASU 2013-11 : UTB is presented as a reduction of the tax unpaid

of a net operating loss (NOL), a similar tax loss, or tax credit

carryforward unless tax law prohibits settlement with NOL/tax

credit

– Effective date

• Public companies : interim & annual periods beginning after

December 15, 2013

• Non-public companies : interim & annual periods beginning after

December 15, 2014


Uncertain Tax Positions, cont’d

• Other UTB related issues– Three requirements related to effectively settled

1)Taxing authority has completed its examinations (including allreviews)

2)No intention to appeal or litigate

3)Remote possibility the taxing authority would examine or re-examine the tax position

− Change in judgment connected to ongoing exam (MLTNrecognition threshold) – NOPA vs. Items discussed but notdocumented

− Indemnification arrangements – evaluation under ASC 450 vs. ASC740

− Presentation – above the line vs. below the line



SEC Comment Letter regarding Uncertain Tax Positions –

ASC 740-10-50-15 disclosures

"Please tell us why you have not made disclosure about

uncertain tax positions under FIN 48. If you believe you have no

uncertain tax positions, please confirm. Please note that FIN 48

applies to taxes based on income (as defined in paragraphs 3

and 4 of SFAS 109) in all taxing jurisdictions.”



SEC Comment Letter regarding Uncertain Tax Positions –

Basis for Recording Changes

“Please clarify the nature of the reductions to the liability for

unrecognized tax benefits for fiscal 2008. If it represents

settlements or lapse of statute limitations reductions, indicate

such in the disclosure. Refer to paragraphs 21(a)(3) and (4) of

FIN 48.”


New Guidance – Discontinued

Operations

• FASB’s final guidance (ASU No. 2014-08) raises the thresholdfor disposals to qualify as discontinued operations. Couldsignificantly reduce number of disposals qualifying as disc ops.

• Only disposed components (or components held-for-sale)representing a strategic shift that have (or will have) a majoreffect on operations and financial results (or that arebusinesses or nonprofit activities held-for-sale at acquisition)will be reported in disc ops.

• Expanded disclosures about disc ops and disposals ofindividually significant components that do not qualify for discops presentation will be required.

• Generally effective in 2015 but early adoption is permitted (i.e.first quarter 2014 for calendar year entities was the firstpermitted period, assuming financial statements had not beenissued).


New Guidance - Goodwill

• FASB issued guidance on 1/16/2014 allowing certain

companies that don’t meet the definition of a “public business

entity” to amortize goodwill acquired in a business combination

on a SL basis over 10 years and to test for impairment only

upon a triggering event

• Effective for annual periods beginning after 12/15/14 and

interim periods within annual periods beginning after 12/15/15.

Early application was permitted (i.e. may have adopted for

2013 financial statements)

• Previously, no amortization allowed. Required to test for

impairment annually or more frequently if indicators of

impairment existed.


Q&A

Patrick R. Hanley

Tax Partner

Hein & Associates LLP

[email protected]

303-294-7710

Brian S. Parmelee

Director, Tax Provision Services

Hein & Associates LLP

[email protected]

303-294-7705

mailto:[email protected]

mailto:[email protected]

ASC 740 – Income Tax Provision Challenges 2014

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